Improved Earnings Required Before Royal Mail plc (LON:RMG) Stock's 25% Jump Looks Justified

Despite an already strong run, Royal Mail plc (LON:RMG) shares have been powering on, with a gain of 25% in the last thirty days. Unfortunately, despite the strong performance over the last month, the full year gain of 5.1% isn't as attractive.

Even after such a large jump in price, Royal Mail may still be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 14.7x, since almost half of all companies in the United Kingdom have P/E ratios greater than 18x and even P/E's higher than 37x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

There hasn't been much to differentiate Royal Mail's and the market's retreating earnings lately. One possibility is that the P/E is low because investors think the company's earnings may begin to slide even faster. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. At the very least, you'd be hoping that earnings don't fall off a cliff if your plan is to pick up some stock while it's out of favour.

Check out our latest analysis for Royal Mail

Want the full picture on analyst estimates for the company? Then our free report on Royal Mail will help you uncover what's on the horizon.

How Is Royal Mail's Growth Trending?

Royal Mail's P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 7.7%. As a result, earnings from three years ago have also fallen 41% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 8.4% per year over the next three years. That's shaping up to be materially lower than the 15% per year growth forecast for the broader market.

With this information, we can see why Royal Mail is trading at a P/E lower than the market. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Final Word

The latest share price surge wasn't enough to lift Royal Mail's P/E close to the market median. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Royal Mail's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You always need to take note of risks, for example - Royal Mail has 2 warning signs we think you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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